October 2016 – Digital Finance Analytics (DFA) Blog

The Interest-Only Loan Debt Trap

Today we discuss some specific and concerning research we have completed on interest-only loans. Less than half of current borrowers have complete plans as to how to repay the principle amount.

Interest-only loans may seem like a convenient way to reduce monthly repayments, (and keep the interest charges as high as possible as a tax hedge), but at some time the chickens have to come home to roost, and the capital amount will need to be repaid.

Many loans are set on an interest-only basis for a set 5 year term, at which point the lender is required to reassess the loan and to determine whether it should be rolled on the same basis. Indeed the recent APRA guidelines contained some explicit guidance:

For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis for the specific term over which the principal and interest repayments apply, excluding the interest-only period

This is important because the number of interest-only loans is rising again. Here is APRA data showing that about one quarter of all loans on the books of the banks are interest-only, and that recently, after a fall, the number of new interest-only loans is on the rise – around 35% – from a peak of 40% in mid 2015. There is a strong correlation between interest-only and investment mortgages, so they tend to grow together. Worth reading the recent ASIC commentary on broker originated interest-only loans.

But what is happening at the coal face? To find out we included some specific questions in our household survey, and today we present the results.

We were surprised to find that around 83% of existing interest-only loan holders expect to roll their loan to another interest-only loan, and to keep doing so. More concerning, only around 44% of borrowing households had an explicit discussion with the lender (or broker) at their last loan draw down or reset about how they plan to repay the capital amount outstanding. Some of these loans are a few years old.

Around 57% said they knew the capital would have to be repaid (we assume the rest were just expecting to roll the loan again) and 26% had no firm plans as to how to repay whereas 39% had an explicit plan to repay.

Many were expecting to close the loan out from the sale of the property (thanks to capital appreciation) at some point, from the sale of another property, or from another source, including an inheritance.

Thus we conclude there is a potential trap waiting for those with interest-only loans. They need a clear plan to repay, at some point. It also highlights that the quality of the conversation between borrower and lender is not up to scratch.

We think some borrowers on an interest-only loan may get a rude shock, when next they try to roll their interest-only loan. If they do not have a clear repayment plan, they may not get a new loan. There is a debt trap laid for the unwary and the APRA guidelines have made this more likely.

Next time we will delve further into the interest only mortgage landscape, because we found the policies of the lenders varied considerably.

Investment Lending On Again

The latest data from APRA for September shows the portfolios of individual banks in Australia as well as details of total loan exposures.

Total lending for housing went to $1.5 trillion, up 7 billion in the month. Of that $5.2 billion was for owner occupation and $1.8 billion for investment loans. As a result 35.5% of loans are for investment purposes.

Looking at the portfolio data, we see that Westpac and CBA had the bulk of the growth, across both owner occupied and investment loans. NAB grew in both categories, whereas ANZ dialed back their investment lending (perhaps from reclassification?). It is worth noting that ING is also growing their owner occupied portfolio and Members Equity Bank grew strongly. Pressure on some of the regional banks continues.

This has done little to change the relative market shares, with CBA in first place on owner occupied loans, and Westpac first on investment lending, but with CBA now nipping at their heals.

Finally, here is the relative investment lending portfolio growth. On a 3 month annualised basis, the total market grew 2.8%, but now three of the major players are operating above system growth, though still below the 10% speed limit imposed by APRA last year.

There has clearly been a focus on energising investment lending, as we predicted in our Property Imperative report. We expect momentum to continue for some time to come, hampering the RBA’s ability to cut the cash rate if they needed to. We still believe further macroprudential measures are needed.

Home Lending Remains Strong In September To $1.6 Trillion

The RBA released their credit aggregates for September today. Overall, lending for housing rose 0.5% to reach another record $1.6 trillion, up $8.6 billion. Within that, owner occupied lending rose 0.6%, up $6.1 billion and investment lending rose 0.4% or $2.5 billion. This is a slightly lower growth rate than a year back (7.5%), but is still strong, well above inflation and wage growth. This means household debts will continue to rise.

The monthly growth rate for investment mortgages shows a sharp move up, and from March 2016, as banks started to focus on lending to this sector. Lending for owner occupation growth rates fell a little, having peaked at the end of last year.

The annualised analysis shows a tilt down, but if recent trends continue, this will reverse. This is hardly a good indicator that housing lending is under control. Indeed, we saw another high auction clearance rate at the weekend.

It is worth noting that there was $1bn of mortgages being switched between owner occupied and investment categories. The proportion of loans for investment purposes is still stitting at 35%. In addition, the proportion of lending to business continues to fall, rising just 0.3% this month, or $2.9 bn. Lending for personal finance fell again, down 0.1%.

The RBA said:

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $45 billion over the period of July 2015 to September 2016, of which $1.0 billion occurred in September 2016. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

Note we have used the seasonally adjusted data in our analysis. You can read our analysis of the companion APRA monthly banking stats here.

ANZ Exits Asian Retail Banking Businesses

ANZ today announced an agreement to sell its Retail and Wealth business in Singapore, Hong Kong, China, Taiwan and Indonesia to Singapore’s DBS Bank. This continues its realignment of its business away from Asia, although ANZ will focus on running a world class Institutional Bank in Asia they said.

The Retail and Wealth business being sold includes ~$11 billion in gross lending assets, ~$7 billion in credit risk weighted assets and ~$17 billion in deposits. In the 2016 financial year, the business accounted for approximately $825 million in revenue and net profit of ~$50 million.

Most people currently employed in ANZ’s Retail and Wealth business will join DBS providing continuity for customers and greater opportunities for staff.

Sale price represents an estimated premium to net tangible assets at completion of ~$110 million. ANZ will take a net loss of ~$265 million including write-downs of software, goodwill and property, and separation and transaction costs. The impact is expected to be slightly higher in the first half of FY2017, but offset back to ~$265m in subsequent periods.

The sale is expected to increase ANZ’s CET1 capital ratio by around 15-20 basis points and is expected to be broadly EPS and ROE neutral.

The transaction is subject to regulatory approvals in each market with completions anticipated over the next 18 months progressively from mid-2017.

ANZ will focus on the Group’s core Asian business in Institutional Banking where it is ranked a top four corporate bank with a significant ongoing presence in 15 Asian countries and $43 billion in gross lending assets.

Commenting on the transaction from Hong Kong, ANZ Chief Executive Officer Shayne Elliott said: “Our strategic priority is to create a simpler, better capitalised, better balanced bank focussed on attractive areas where we can carve out winning positions.

“Asia remains core to ANZ’s strategy. This transaction simplifies our business while allowing us to continue to benefit from higher levels of growth in the region through a focus on our largest, most successful business in Asia – banking large corporate and institutional clients
driven by trade and capital flows particularly with Australia and New Zealand.

“By focussing our resources in Asia – whether that is capital, technology or people – on Institutional Banking, we can continue to build a world-class, capital efficient business by strengthening our network and the support we provide to our key institutional clients.

“In Retail and Wealth, although we have grown a profitable business in Asia, without greater scale ANZ’s competitive position is not as compelling.
“Having looked carefully at the business in recent months, it is clear the environment we face has changed and to make a real difference for our Retail and Wealth customers, we would need to make further investments in our Asian branch network and digital capability.

Further investments do not make sense for us given our competitive position and the returns available to ANZ,” Mr Elliott said.

Germany Tightens Residential Mortgage Lending

Moody’s says last Tuesday, German stock exchange gazette Börsen-Zeitung reported that Germany’s Ministry of Finance had proposed a draft law aimed at tightening residential mortgage lending market regulations. Once enacted, German Financial Services Authority BaFin would be authorised to tighten residential mortgage loan origination criteria to prevent house prices from overheating. This would be credit positive for mortgage Pfandbriefe (covered bonds) and residential mortgage-backed securities (RMBS) because it would reduce the risk of households taking on excessive debt during times of inflated house prices.

The proposal comprises four components: a maximum loan-to-value (LTV) ratio, a minimum loan amortisation requirement, a maximum debt-service-to-income (DSTI) ratio and a maximum debt-to-income (DTI) ratio. The finance ministry’s proposal follows the German Financial Stability Committee’s 2015 recommendation to the German government to develop instruments to regulate residential mortgage loan origination.
The government’s proposal would only affect newly originated residential mortgage loans because of a grandfathering rule. Therefore, the credit strength of covered bond programmes and RMBS would improve over time, particularly by reducing borrower default, where a maximum LTV ratio will fall below currently LTV ratios.

Exhibit 1 provides an overview of Moody’s-rated German mortgage Pfandbriefe in which the residential mortgage loan portion exceeded 50% of total cover pool assets as of 30 June 2016. Covered bondholders of ING DiBa’s mortgage Pfandbriefe would benefit the most from a maximum LTV ratio because its cover pool has the highest share of residential mortgage cover assets (97.9%) and the highest weighted average whole-loan-to-lending-value5 ratio (99.6%). Based on lending values, 32.2% of ING DiBa’s residential mortgage cover assets have a whole-loan-to-value ratio above 100%.

The whole-loan-to-value ratio is not only an important driver of the probability of borrower loan defaults, but also of recoveries following a borrower’s default. If the BaFin were to set the maximum loan-to-lending value ratio above 60%, Pfandbriefe would not benefit from improved recoveries following borrower default. This is because under the Pfandbrief Act covered bonds may only be issued against loans backed by up to 60% of the property’s lending value. However, the Pfandbrief Act does not limit how much borrowers can borrow against a property. The same applies to the typical eligibility criteria of an RMBS transaction. Therefore, and because lending to residential borrowers has steadily increased since 2010 (see Exhibit 2), a maximum DTI ratio would be credit positive for mortgage Pfandbriefe and German RMBS. This is particularly applicable in the current low interest rate environment, where borrowers’ affordability for large loans has substantially improved.

ASIC report highlights a deep culture problem in Australia’s banks

From The Conversation.

In it’s latest report, the Australian Securities & Investments Commission (ASIC) found the big four banks sold products to some customers through their adviser network, with a fee for ongoing advice, but the advice was never given.

None of this came to light until the banks were asked by ASIC to look at adviser compensation, following the introduction of the Future of Financial Advice (FOFA) legislation in 2013.

No wonder the banks were wary of their practices being investigated. Not only has it come to light that many customers (176,000 at the last count) were being charged for services they were not receiving but, in many cases, the banks didn’t have the data they needed to find out whether customers had been dudded or not.

And ASIC is pretty sure why such systemic issues emerge at regular intervals, stating:

Cultural factors in the banking and financial services institutions covered by this report may have contributed to the systemic failures we observed.

The ASIC report details the reason for the cultural failings it observed in the wealth management businesses of the major banks:

Some advice licensees prioritised advice revenue and fee generation over ensuring that they delivered the required services.

ASIC found that the IT systems in wealth management in the major banks were stone-aged at best. The banks appear to have no idea what they don’t know, but are all working to identify how many more customers need to be compensated.

ASIC also found that some banks failed to keep complete or accurate records to enable compliance to be analysed. And in some cases, authorised representatives had taken customers’ files with them when they left the firms, making it impossible to check whether or not advice was given.

It appears that every time a question is asked of the big banks, another example of bad behaviour is unearthed.
Australia’s big four banks (CEOs pictured) are facing further criticism from regulatory bodies. Lukas Coch/AAP
In the recent questioning of bank CEOs by the House Economics Committee, questions were raised with all CEOs about systemic issues. The answers were generally evasive and short on specifics.

For example, when talking about a different but related, financial planning scandal, Andrew Thorburn, NAB CEO, said:

“We did a review and we had an independent party come and do that review with us, and we concluded and we stand by that, that it was not a systemic issue.”

What Mr Thorburn and other CEOs neglected to mention was that the banks had, as revealed in ASIC’s report, all already been in the middle of deep discussions about so-called “fee-for-services failures” . The regulator wrote:

Of particular concern is that many of the banking and financial services institutions covered by this review publicly state that their core values include being customer focused, “doing what is right” for customers, and acting with integrity. We encourage the institutions reviewed in this report to consider how their culture may have supported these systemic failures, and why their stated commitment to providing excellent service to customers is not translating into good outcomes for customers in the many instances we identified in this report.

At long last, ASIC has highlighted cultural issues across the industry that the boards and management of the largest banks have long refused to acknowledge.

The regulator has done its job and found compelling evidence that the culture of the banks is rotten.

It’s over to the politicians now.

Author: Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University

More Households Risk Default – Veda

Although the majority of Australians consider themselves financially responsible when paying bills and sticking to a budget, a quarter of the population (26%) are splashing their cash on things they know they will struggle to repay says Veda.

Millennials are leading the pack, with 36% of people aged under 30 admitting to overspending according to new research from Veda, Australia and New Zealand’s provider of consumer and commercial data and insights and a wholly-owned subsidiary of Equifax.

The Veda Australian Credit Scorecard offers market-leading insights into credit habits and VedaScores. It combines an analysis of more than two million VedaScores with consumer research of 1,000 Australians. A VedaScore provides a snapshot of an individual’s creditworthiness, which is useful to know when applying for credit.

Queensland is the state with the highest default risk of 20 per cent, whilst the Australian Capital Territory scored lowest.

Izzy Silva, Veda’s General Manager, Consumer, said the tendency of younger people to overspend was reflected in their credit scores, revealed in the fourth annual Veda Australian Credit Scorecard.

“Millennials (Gen Y) top the table for the generation at highest risk of default within the next 12 months, with 23% of this group considered at risk, compared to 17% of the total population,” Mr Silva said.

In 2016, Millennials also have the lowest average VedaScore (712) and are the only generational group to have an average score lower than the 2016 national average (757).

The good news is Veda’s data shows that the average VedaScore of 757 for Australians in 2016 is considered a very good score.

“It is clear that Australians are more aware of how their credit score can get them a better deal, with an increase in people accessing their credit score to 23%, compared to only 11% in 2015. However, Australians say they want to ‘live in the now’ and tend to splash the cash without worrying about the future – 32% of consumers admitted to this behaviour (up from 24% last year),” Mr Silva added.

Generally speaking, women are more financially conscious than men with the average VedaScore for women sitting at 768, compared to the average VedaScore for men of 749. This financial conscientiousness is illustrated by the statistic that only 13% of women are likely to overspend because they think they deserve it, compared to 23% of men.

“By maintaining a high VedaScore, consumers demonstrate to lenders that they are in control of their credit and spending habits, which in turn makes them a lower credit risk and more attractive to lenders, thus helping them secure better financial opportunities,” Mr Silva said.

Australian Credit Attitudes

Social researcher Mark McCrindle said that gender and age were just two of a number of factors that influenced an individual’s financial personality.

“Through the research conducted by Veda, we have seen a segmentation of people’s attitudes towards credit and there are four individual archetypes we have identified. These are: Money Masters, Slapdash Strivers, Secure Savers and Financial Fumblers.

“Each of the archetypes is shaped by influences including age, income, gender, and work status. There are distinct attitudes and behaviours exhibited by each archetype group,” Mr McCrindle added.

Money Master – Generally classified as wise and knowledgeable when it comes to managing their own credit, with friends and family members often coming to them for advice in regard to their financial goals. Money Masters tend to be predominantly male, work full-time and have a healthy expendable income which they can invest into financial securities.

Slapdash Striver – Often people who take financial risks without completely understanding the consequences. They also consider themselves financially ambitious and have the potential to reach their financial goals with further knowledge of the credit landscape. Slapdash Strivers tend to work full-time and achieve a higher income than the majority of Australians, with an even split between males and females.

Secure Saver – People who are living comfortably within their financial environment and would prefer not to spend money with credit on unnecessary items as they are well informed about money management. They typically have a strict budget and plan ahead for future uncertainty. People who are classified as Secure Savers tend to be female and from the Baby Boomer generation who either work part-time, or are retired.

Financial Fumbler – Often people who live payday to payday and can get overwhelmed when setting financial goals. They are unaware of the benefits of credit and don’t have the appropriate knowledge to invest their money in the right places. With better planning and knowledge, they can get back on track and head towards a positive future. People who are classified as Financial Fumblers tend to be on the lower end of the income spectrum, such as students and/or under 35 (Millennials or Gen Y).

Another Strong Auction Result Today

Domain has released their preliminary analysis of auction clearance rates today. Nationally, 78.3% of the 1,585 listed cleared, with Sydney hitting 81.4% and Melbourne 78.3%. Volumes are down on last year somewhat, but clearance rates remain much higher.

Brisbane cleared 58% of 131 listings, Adelaide 77% of 105 listed, and Canberra 70% of 74 listed. So we continue to see momentum in the Sydney and Melbourne markets. No surprise this meshes with recent home price rises.

The UK Uber Ruling, And The Sharing Economy

The UK landmark ruling, made Friday, could have profound impacts on the sharing economy. Uber drivers were found to be “employed” rather than “self-employed” and as such should be eligible for minimum wages, holiday pay and other benefits. Uber said it would appeal the decision because its business was a matching service between potential customers and lift providers.

But it begs the wider question. Are these new economy sharing businesses truly not employing those providing the services, and are workers truly self-employed? The resolution of this issue has profound consequences, not just for the estimated 40,000 Uber workers in the UK but where it has been suggested that more than 460,000 people are not really self-employed and more than £300m in taxes are foregone each year.

Many other sharing business exist, in the UK, and elsewhere, and the ever deeper migration to digital means we must expect to see more people being employed in the “gig” economy.

Last year Deloitte Access Economics reported the sharing economy contributes about A$504 million a year to the New South Wales economy, with about 45,000 people earning an income from the different platforms like Lyft and Uber for ride sharing, and Airbnb for accommodation.

We have to decide whether to fit the “gig” type business into the current work definitions, or whether there is a need for a new type of worker – one providing perhaps occasional services in the sharing economy.

One of the attractions of working in the sharing economy is the freedom and flexibility it offers, but incumbents argue this is an unfair advantage, and they should be working within existing employment frameworks, which are designed to protect workers, and those using the provided services.

We think this needs some careful thought. UK MPs last week launched an inquiry into pay and working conditions, including the issues of casual workers, agency, and the gig economy. The rules in Australia are no clearer.

Do we fight or embrace the innovation, or find some middle path. The stakes are high.

We said in an earlier post:

The sharing economy has the potential to disrupt current business models, whether its taxis, banking, accommodation or a range of other areas. It also has the potential to be stopped dead in its tracks, if incumbents, or regulation get to dictate too much too soon.

I suggest we should bias the regulatory framework to encourage new businesses to develop. Tender plants need carefully husbandry. Legislators must take the time to get the rules right, but with a bias towards facilitating disruption, not stopping it. In Australia, our track record on this is frankly poor, and incumbents often have such strong influence (at a market, and political level) that as a result new sharing economy businesses are likely to get crushed.

Initial US Q3 Growth Estimate Higher

The US Bureau of Economic Analysis says real gross domestic product increased at an annual rate of 2.9 percent in the third quarter of 2016, according to the “advance” estimate. In the second quarter, real GDP increased 1.4 percent.

However a key inflation indicator in the GDP report, the personal consumption expenditures price index, slowed from the second quarter to a 1.4 percent annual rate. The Fed has focused its easy money policy on boosting inflation to 2.0 percent, based on the broader PCE price index.

The Bureau emphasized that the third-quarter advance estimate released is based on source data that are incomplete or subject to further revision by the source agency. The “second” estimate for the third quarter, based on more complete data, will be released on November 29, 2016.

Real GDP: Percent Change from Preceding Quarter

The increase in real GDP in the third quarter reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, federal government spending, and nonresidential fixed investment that were partly offset by negative contributions from residential fixed investment and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP growth in the third quarter reflected an upturn in private inventory investment, an acceleration in exports, a smaller decrease in state and local government spending, and an upturn in federal government spending. These were partly offset by a smaller increase in PCE, and a larger increase in imports.

Current-dollar GDP increased 4.4 percent, or $201.1 billion, in the third quarter to a level of $18,651.2 billion. In the second quarter, current dollar GDP increased 3.7 percent, or $168.5 billion.

The price index for gross domestic purchases increased 1.6 percent in the third quarter, compared with an increase of 2.1 percent in the second quarter (table 4). The PCE price index increased 1.4 percent, compared with an increase of 2.0 percent. Excluding food and energy prices, the PCE price index increased 1.7 percent, compared with an increase of 1.8 percent.

Personal Income

Current-dollar personal income increased $153.6 billion in the third quarter, compared with an increase of $153.1 billion in the second.

Disposable personal income increased $125.3 billion, or 3.6 percent, in the third quarter, compared with an increase of $140.6 billion, or 4.1 percent, in the second. Real disposable personal income increased 2.2 percent, compared with an increase of 2.1 percent.

Personal saving was $800.6 billion in the third quarter, compared with $793.5 billion in the second. The personal saving rate — personal saving as a percentage of disposable personal income — was 5.7 percent in the third quarter, the same as in the second.